Banks enter into a large number of transactions in the ordinary course of their operations. Some of these transactions carry financial risk. For example, with individual loans the risks typically include a risk of debtor default or risks presented by changing interest rates for variable rate loans or imminently mature loans (whose principal likely will be reinvested at a new interest rate). Typically, banking regulations require that banks own other instruments whose behavior counterbalances risks presented by the first instruments. This is called “hedging.” Risks presented by a first, typically large, set of instruments (called, “hedged items” herein) are counterbalanced by performance of a second, typically much smaller, set of instruments (called, “hedging instruments” herein), such that when risk rises in the hedged items, risk falls in the hedging instruments. The hedged items and the hedging instruments may be grouped into one or more hedging relationships. On a cash flow basis, for each hedging relationship, the performance of the hedging instruments must match the performance of the hedged items within a predetermined criterion. As noted, these criteria typically are established by regulation but they also may be set by a bank's individual hedging policy.
To ascertain whether a bank's financial positions meet the prescribed hedging requirement, a system for evaluating cash flows of each hedging relationship's hedged items and hedging instruments may be used. The types and number of transactions into which a bank enters may constantly change and instruments held by a bank may mature. Since a bank's hedged items and hedging instruments constantly change, a bank must actively manage its hedging positions. If a bank determines that it does not own sufficient hedging instruments to effectively hedge a set of hedged items, the bank must search for and purchase additional instruments to render its hedging position compliant.
Accordingly, there is a need in the art for a system and method for determining the effectiveness of simulated assignments of hedging instruments to hedging relationships.